The Aftermath of Catastrophes: Valuing Business Interruption Insurance Losses

Penn State Law From the SelectedWorks of Christopher C. French 2014 The Aftermath of Catastrophes: Valuing Business Interruption Insurance Losses Chris French Available at: http://works.bepress.com/chris_french/9/

THE AFTERMATH OF CATASTROPHES: VALUING BUSINESS INTERRUPTION INSURANCE LOSSES Christopher C. French * ABSTRACT With the onslaught of tornadoes, hurricanes, and floods in recent years, business interruption losses have been staggering. Many businesses do not survive such catastrophes. Even business owners that purchased business interruption insurance, which is intended to ensure that a business s revenue stream continues during an interruption in its operations, often find that their insurers have dramatically different views regarding the amount of the losses that should be reimbursed. The reason for this disparity in views is that the loss valuation provisions in business interruption insurance policies provide very little guidance regarding how business interruption losses should be calculated. Thus, disputes regarding the valuation of business interruption losses frequently arise and courts and juries are forced to resolve such disputes with widely varying, inconsistent, and unpredictable results. This lack of predictability has placed a burden on the legal system because far more business interruption cases are tried than are necessary. This Article analyzes the origins and purpose of business interruption insurance, as well as the courts inconsistent interpretations of the standard form business interruption loss valuation provisions. The Article then offers an interpretation of the existing loss valuation provisions under the rules of policy interpretation and considers whether the result would be different if * Christopher C. French is a Visiting Assistant Professor at the University of Pittsburgh School of Law; J.D., Harvard Law School; B.A., Columbia University. The author gratefully acknowledges the legal research contributions of Amanda Lusk to this article. The author also would like to thank Daniel Schwarcz, Jim Chen, and all of the participants in a workshop at Villanova Law School for providing thoughtful comments on earlier drafts of this article. 461

462 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 the language were analyzed from a product liability perspective in light of the fact that policies are non-negotiated contracts of adhesion sold on a take-it-or-leave-it basis. The Article concludes with an analysis of the public policy considerations related to the payment of business interruption insurance losses and proposes alternative loss valuation formulas to be used in the future that should provide for consistent, fair and predictable loss valuations and payment of claims without litigation. TABLE OF CONTENTS INTRODUCTION... 463 I. RELEVANT POLICY LANGUAGE... 469 A. The Origins of Business Interruption Insurance... 469 B. The Policy Language Regarding the Valuation of Business Interruption Losses... 470 II. COURTS INTERPRETATION AND APPLICATION OF THE POLICY LANGUAGE REGARDING THE VALUATION OF BUSINESS INTERRUPTION LOSSES... 472 A. Courts That Have Interpreted the Loss Valuation Language to Allow for Consideration of Only Historical Financial Data... 473 B. Courts That Have Interpreted the Loss Valuation Language to Allow for the Consideration of Local Economic Conditions Post-Catastrophe... 477 C. Courts Inconsistent Holdings Regarding the Application of the Loss Valuation Language... 481 D. Courts Confusion Regarding the Evidentiary Standard Under Which Business Interruption Losses Must be Proven... 486 III. PRINCIPLES OF INSURANCE POLICY INTERPRETATION RELEVANT TO VALUING BUSINESS INTERRUPTION LOSSES... 490 A. The Doctrine of Contra Proferentem... 490 B. The Reasonable Expectations Doctrine... 493 C. Construction of the Policy as a Whole... 496 IV. HOW BUSINESS INTERRUPTION LOSSES SHOULD BE VALUED... 496 A. The Problems with the Existing Framework... 497

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 463 1. Business Interruption Loss Valuations are Inherently Speculative so They Cannot be Proven with Reasonable Certainty... 497 2. Using Only the Policyholder s Historical Financial Information to Value Business Interruption Losses Ignores Some of the Valuation Policy Language... 499 3. Consideration of the Post-Catastrophe Economic Conditions Can Lead to Unfair Results and Factual Disputes That Must be Tried... 502 B. How Business Interruption Losses Should be Valued Under the Existing Policy Language... 504 1. Applying the Rules of Policy Interpretation to Loss Valuation Language... 505 2. Analyzing the Loss Valuation Policy Language as a Defective Product... 508 C. Proposed Loss Valuation Formulas That are Based Upon the Original Purpose of Business Interruption Insurance and Which Provide Consistent, Predictable Results and the Efficient Resolution of Claims... 510 1. A Stated Daily Loss Value Set Forth in the Policy or Only the Policyholder s Prior Three Years of Historical Earnings and Expenses Should be Used When Valuing Business Interruption Losses... 511 2. Public Policy Considerations... 515 CONCLUSION... 519 INTRODUCTION Business interruption losses caused by natural and unnatural disasters are enormous. For example, the business interruption losses associated with the 9/11 terrorist attack have been estimated to exceed $10 billion. 1 Hurricane Katrina caused more than $45 billion in damage. 2 The governors of New York and New Jersey estimated that Hurricane Sandy caused more than $60 billion in damages. 3 1. DANIEL T. TORPEY, DANIEL G. LENTZ & ALLEN MELTON, BUSINESS INTERRUPTION: COVERAGE, CLAIMS, AND RECOVERY 4 (2d ed. 2011). 2. Gregory D. Miller & Joseph D. Jean, Effect of Post-Loss Economic Factors in Measuring Business Interruption Losses: An Insured s and Insurer s Perspectives, in NEW APPLEMAN ON INSURANCE: CURRENT CRITICAL ISSUES IN INSURANCE LAW 25, 25 (2010). 3. Editorial, Hurricane Sandy s Rising Costs, N.Y. TIMES, Nov. 28, 2012, at A32.

464 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 Many businesses impacted by such disasters never recover. Indeed, the United States Department of Labor has estimated that 40% of businesses never reopen after experiencing a disaster. 4 Of those that do, at least 25% fail within two years. 5 Now imagine a business owner in an area that was just struck by a flood, tornado, or hurricane. The business was damaged such that operations had to be suspended. Lucky for the business owner, however, he was able to resume operations in a few weeks or months after repairs were made. Even better, he had the foresight to purchase business interruption insurance, which is intended to place the business owner in the position he would have occupied if the catastrophe had not occurred. 6 Yet, when the business owner submits a business interruption claim to the insurer, the insurer denies coverage for the claim or offers a paltry sum and advises the business owner that there would have been little or no demand for the business s services or products during the time period its operations were being restored because the area near the business was wiped out by the disaster. Thus, the insurer tells the business owner that the business did not actually suffer a business interruption loss because very few customers or clients would have patronized the business following the disaster even if the business had not been impacted. At best, the insurer tells the owner, what little business he might have had would not have covered the business s fixed costs such as rent and payroll. 7 Consequently, the insurance policy purchased to cover business interruption losses provides little or no recovery because the business s projected earnings during the period of interruption would not have exceeded its continuing fixed costs. 8 4. John Grossman, A Business Ponders Whether Its Location is Perfect, or a Disaster, N.Y. TIMES, Dec. 8, 2011, at B6. 5. Id. 6. Miller & Jean, supra note 2, at 25 ( Business interruption insurance, at its core, is intended to place the insured in the position it would have been in had it not suffered a loss. ); Jon C. Rice, Business Interruption Coverage in the Wake of Katrina: Measuring the Insured s Loss in a Volatile Economy, 41 TORT TRIAL & INS. PRAC. L.J. 857, 857 (2006) ( The purpose of business interruption coverage is to place the insured in the position it would have occupied had no interruption occurred. ). 7. See, e.g., Cont l Ins. Co. v. DNE Corp., 834 S.W.2d 930, 933 (Tenn. 1992). 8. Id.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 465 Unfortunately, this is not a fictional scenario. It is all too real and it is regularly experienced by many business owners throughout America. There are countless business owners in New Jersey and New York that are currently going through such an experience right now in the wake of Hurricane Sandy. Insurers take such a position due to the nebulous wording of the loss valuation provisions buried in lengthy, complex, standard form business interruption insurance policies that insurers draft and then sell on a take-it-or-leave-it basis. 9 The loss valuation language often is worded as follows: In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred. 10 9. Wagner v. Yates, 912 N.E.2d 805, 811 (Ind. 2009) ( [T]he insurer drafts the policy and foists its terms upon the customer. ); 401 Fourth Street, Inc. v. Investors Ins. Grp., 879 A.2d 166, 171 (Pa. 2005) ( [T]he insurer drafts the policy, and controls coverage. ). See also 1 JEFFREY W. STEMPEL, LAW OF INSURANCE CONTRACT DISPUTES 4.06(b), at 4-37 (2d ed. Supp. 2005) ( In a sense, the typical insurance contract is one of super-adhesion in that the contract is completely standardized and not even reviewed prior to contract formation. ); Kenneth S. Abraham, A Theory of Insurance Policy Interpretation, 95 MICH. L. REV. 531, 534 (1996); Michelle Boardman, Insuring Understanding: The Tested Language Defense, 95 IOWA L. REV. 1075, 1091 (2010) (describing the hyperstandardization of insurance policies); James M. Fischer, Why Are Insurance Contracts Subject to Special Rules of Interpretation?: Text Versus Context, 24 ARIZ. ST. L.J. 995, 996 (1992) ( The only part of the standard policy that is generally customized to the consumer-insured is the Declarations Sheet.... [T]here is little, if any, freedom to negotiate the standardized language of the insurance contract that determines the scope of coverage. ); Jonathan R. Macey & Geoffrey P. Miller, The McCarran-Ferguson Act of 1945: Reconceiving the Federal Role in Insurance Regulation, 68 N.Y.U. L. REV. 13, 18 (1993); Susan Randall, Freedom of Contract in Insurance, 14 CONN. INS. L.J. 107, 125 (2007) ( [I]n some lines of insurance, all insurance companies provide identical coverage on the same take-it-or-leave-it basis. ); Daniel Schwarcz, Reevaluating Standardized Insurance Policies, 78 U. CHI. L. REV. 1263, 1266 67, 1276 (2011) (citing sources that discuss the standardization of insurance policies and then arguing homeowners insurance policies are not as standardized as other lines of insurance); Kent D. Syverud, The Duty to Settle, 76 VA. L. REV. 1113, 1153 (1990) ( [P]roperty owner s liability insurance contracts are standardized across insurers in a form few insureds have the power or experience to bargain around. ). 10. Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005) (emphasis added).

466 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 Insurers rely upon the above italicized language when they attempt to support the argument that business interruption losses are negligible or non-existent in situations where the area surrounding a business has been destroyed by a catastrophe such that the demand for the impacted business s services or products has been greatly reduced or eliminated. 11 Other times, if the catastrophe results in increased demand for the policyholder s services or products, then the insurers argue only the pre-catastrophe sales and expenses of the policyholder should be used to value the loss. 12 Some courts have accepted the argument that the economic conditions post-catastrophe should be considered when valuing business interruption losses. 13 Other courts have not. 14 Courts also have disagreed regarding which elements of a business interruption loss are recoverable. 15 In addition, some courts have required the policyholder to prove the amount of any business interruption loss to a reasonable degree of certainty even though such calculations are, by necessity, only projections regarding what the policyholder would have earned in the hypothetical world in which the catastrophe did not occur. 16 All of these inconsistencies and problems reflected in the courts decisions flow from the nebulous valuation language that is contained in business interruption policies. In this Article, the author contends that if the existing policy language continues to be used, then the ambiguities in it should be construed in favor of policyholders and against insurers, which should lead to inconsistent results that consistently favor policyholders. A better approach, however, would be to redraft the loss valuation provisions. Instead of using the vague loss valuation language that currently exists, business interruption policies should include a stated daily loss value for business interruption claims, which already is developed and used during the underwriting 11. See infra Part II. 12. See infra Part II.B. 13. Id. 14. See infra Part II.A. 15. See infra Part II.C. 16. See infra notes 120, 121.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 467 process. 17 The stated daily loss value is the amount, at the time the policy is placed, that the policyholder is projected to lose on a daily basis if its operations are interrupted. 18 It is a number that is derived from the policyholder s current expense and revenue data and is revised annually during the policy renewal process so it always is up to date. Insurers already use the number during the underwriting process to assess the risk and establish the amount of the premium. 19 Alternatively, only the policyholder s earnings and cost data for the three years prior to the business interruption could be used to value business interruption losses. Using a three-year time period should account for the seasonal or cyclical nature of some businesses revenue streams. The advantages of using either proposal are that they establish a fixed number that is agreed to by the parties at the time the policy is placed regarding the amount a policyholder will be paid if its operations are interrupted. Both proposals would eliminate debates between the parties regarding the state of the economy, the trends in the policyholder s industry, and the impact the catastrophe had on the local business climate. Such debates are at the center of the current litigation regarding business interruption losses and they result in an enormous waste of the parties and courts resources as cases unnecessarily wind their way through the legal system and are ultimately presented to juries because the outcomes of the cases are unpredictable under the existing policy language. 20 Thus, if adopted, either proposal would provide consistent, predictable results and the efficient resolution of claims without the necessity of litigation in most instances. This Article addresses these issues in four parts. Part One discusses the origins and purpose of business interruption insurance, which is to ensure that the policyholder s revenue stream continues during the period of interruption, as well as the policy language 17. See infra note 216. 18. Stan Johnson & Kevin O Toole, Common Business Interruption Measurement Disputes, 19 JOHN LINER REV. 59, 65 (2005). 19. See infra note 216. 20. See infra Part II.

468 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 relevant to the valuation of business interruption losses. Part Two discusses the conflicting court opinions regarding the valuation of business interruption losses. Part Three discusses the rules of policy interpretation that are relevant to interpreting and applying the existing policy language. Part Three also explores the idea that, in light of the fact that policies are non-negotiated contracts of adhesion sold on a take-it-or-leave-it basis, the loss valuation language can be viewed as a defective product if the policy fails to perform as reasonably expected by the policyholder (i.e., the policyholder does not receive payment from the insurer for the full amount of the policyholder s business interruption loss). Part Four discusses the problems with the existing policy language and current approaches to valuing business interruption losses. Part Four also discusses public policy considerations, such as the importance of ensuring that policyholders receive the benefit of the bargain for the premiums they paid, and ensuring that the socially important purpose of insurance transferring the risk of losses from individuals and businesses to insurers is not frustrated by insurers interest in maximizing their profits by minimizing the amounts they pay for catastrophic losses by relying upon vaguely-worded loss valuation provisions they themselves drafted and buried in policies that often exceed fifty pages of single-spaced terms, conditions and exclusions. The Article concludes with the author s proposal that instead of using the existing policy language, the policies either should contain a daily loss value or specify that only the policyholders prior three years of revenue and cost data will be used to calculate business interruption losses. If insurers will not voluntarily redraft the loss valuation language to clarify how business interruption losses will be calculated, then the author proposes that: (1) courts should construe the nebulous loss valuation language strictly against insurers as required under the existing rules of policy interpretation, and (2) legislatures should enact legislation that dictates how business interruption losses will be valued in accordance with one of the proposals made in this Article.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 469 I. RELEVANT POLICY LANGUAGE A. The Origins of Business Interruption Insurance The genealogy of business interruption insurance begins over two hundred years ago and has its roots in insurance that was issued to protect property owners rental income. 21 Because property insurance historically did not protect against lost rent, separate coverage had to be purchased. 22 Originally, such insurance was referred to as use and occupancy insurance. 23 In the 1930s, the name evolved to business interruption insurance and in the 1980s the Insurance Services Office (ISO) coined the term business income insurance when it issued a new policy form for business interruption insurance. 24 As many courts and commentators have stated, the purpose of business interruption insurance is to return the policyholder to the position it would have occupied if the disaster had not occurred: The purpose of business interruption insurance is to protect the insured against losses that occur when its operations are unexpectedly interrupted, and to place it in the position it would have occupied if the interruption had not occurred. 25 The modern forms of business interruption insurance, which cover net profits plus continuing expenses such as payroll and taxes, were introduced in the mid-1920s. 26 There currently are two common business interruption policy forms: 1) Gross Earnings and 2) Business Income. 27 Gross Earnings forms calculate business 21. TORPEY, LENTZ & MELTON, supra note 1, at 1. 22. Id. 23. Id. at 5. Use and occupancy insurance typically had a loss per day value set forth in the policy. Id. at 6. Consequently, there was no need for, and little room to, debate what the amount of lost income was in the event of a business interruption. Id. 24. Id. at 5. 25. Cont l Ins. Co. v. DNE Corp., 834 S.W.2d 930, 934 (Tenn. 1992) (citing Nw. States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1966)). See also Miller & Jean, supra note 2, at 25; Rice, supra note 6, at 857. 26. TORPEY, LENTZ & MELTON, supra note 1, at 8. 27. Id. at 9, 14 (describing the gross earnings form and the business income form). See also David A.

470 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 interruption losses from the top down, which means the business interruption loss is the total amount the policyholder would have earned if not for the interruption of its operations less the costs or expenses the policyholder did not incur due to the interruption in its business (i.e., the variable costs it saved because its operations were suspended). 28 Business Income forms calculate business interruption losses from the bottom up, which means the business interruption loss is the net income the policyholder would have earned if not for the interruption plus the policyholder s continuing fixed expenses such as payroll and taxes. 29 In theory, the amount of a business interruption loss should be the same under the two policy forms. 30 B. The Policy Language Regarding the Valuation of Business Interruption Losses Although there are many minor variations in the wording used in business interruption policies because insurers often have their own policy form that they prefer to use, all such forms are drafted by insurers. 31 The policies are contracts of adhesion and sold on a takeit-or-leave-it basis. 32 One common version of the insuring agreement language found in Gross Earnings policy forms provides: [The insurer] shall be liable for the ACTUAL LOSS SUSTAINED by insured resulting directly from such interruption of business, but not exceeding the reduction in gross earnings less charges and expenses which do not necessarily Borghesi, Business Interruption Insurance: A Business Perspective, 17 NOVA L. REV. 1147, 1150 (1993) (discussing the types of business interruption policy forms); Lori R. Keeton, Business Interruption Coverage in the Wake of the Gulf Coast Oil Spill: The Devil Is in the Details, ASPATORE (Mar. 2011), 2011 WL 971800, at *6. 28. TORPEY, LENTZ & MELTON, supra note 1, at 10 12; Borghesi, supra note 27, at 1150; Keeton, supra note 27, at *6. 29. TORPEY, LENTZ & MELTON, supra note 1, at 15; Borghesi, supra note 27, at 1150; Keeton, supra note 27, at *6. 30. Borghesi, supra note 27, at 1150. 31. See supra note 9. 32. Id.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 471 continue during the interruption.... 33 In short, the policyholder is entitled to recover its lost gross earnings less saved variable expenses. A common version of the insuring agreement language used in Business Income policy forms is worded as follows: [The insurer] will pay an insured during its period of suspended business operation the (i) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred... ; and (ii) Continuing normal operating expenses incurred, including payroll[.] 34 In short, the policyholder is entitled to recover its net profits plus fixed continuing expenses. The loss valuation provisions are commonly worded as follows: In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred. 35 33. Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005). For similar insuring agreement language, see also Catlin Syndicate Ltd. v. Imperial Palace of Miss., Inc., 600 F.3d 511, 514 (5th Cir. 2010); Prudential LMI Commercial Ins. Co. v. Colleton Enters., Inc., No. 91-1757, 1992 WL 252507, at *1 (4th Cir. Oct. 5, 1992); Consol. Cos. v. Lexington Ins. Co., No. 06-4700, 2009 U.S. Dist. LEXIS 8542, at *16 17 (E.D. La. Jan. 23, 2009); Berk-Cohen Assocs. v. Landmark Am. Ins. Co., No. 07-9205, 2009 WL 2777163, at *3 (E.D. La. Aug. 27, 2009); B.F. Carvin Constr. Co. v. CNA Ins. Co., No. 06-7155, 2008 WL 5784516, at *1 (E.D. La. July 14, 2008); Levitz Furniture Corp. v. Hous. Cas. Co., No. 96-1790, 1997 WL 218256, at *3 (E.D. La. Apr. 28, 1997); Am. Auto. Ins. Co. v. Fisherman s Paradise Boats, Inc., No. 93-2349CIVGRAHAM, 1994 WL 1720238, at *3 (S.D. Fla. Oct. 3, 1994). 34. Amerigraphics, Inc. v. Mercury Cas. Co., 107 Cal. Rptr. 3d 307, 312 (Cal. Ct. App. 2010) (quoting policy language). For similar insuring agreement language, see also Catlin Syndicate Ltd., 600 F.3d at 514; Finger Furniture, 404 F.3d at 314; Prudential LMI Commercial Ins. Co., 1992 WL 252507, at *1; Consol. Cos., 2009 U.S. Dist. LEXIS 8542, at *16 17; Berk-Cohen, 2009 WL 2777163, at *4; B.F. Carvin Constr. Co., 2008 WL 5784516, at *1; Levitz Furniture Corp., 1997 WL 218256, at *3; Am. Auto. Ins. Co., 1994 WL 1720238, at *3. 35. Finger Furniture, 404 F.3d at 314 (emphasis added). See also cases cited infra notes 44, 67.

472 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 Notably, the term gross earnings is not defined in the policies. 36 Also, this language clearly contemplates doing a projection regarding the business s probable experience if the loss had not occurred. 37 Another version of the valuation language that also is often used provides: We ll cover your actual loss of earnings and extra expenses incurred because of necessary or potential interruption of business.... In figuring earnings, we ll weigh the performance of your business before the loss and what its performance probably would have been afterwards had no loss occurred. 38 Again, the language contemplates that an analysis will be conducted regarding what the policyholder s hypothetical performance probably would have been if no loss had occurred. 39 II. COURTS INTERPRETATION AND APPLICATION OF THE POLICY LANGUAGE REGARDING THE VALUATION OF BUSINESS INTERRUPTION LOSSES Due to the broad language used in the loss valuation provisions of business interruption insurance, the use of many undefined terms, and the fact that a formula for valuing business interruption losses is not actually contained in such provisions, it should come as no 36. Finger Furniture, 404 F.3d at 314. 37. Id. 38. Cohen Furniture Co. v. St. Paul Ins. Co. of Ill., 573 N.E.2d 851, 855 (Ill. App. Ct. 1991) (emphasis added). See also cases cited infra notes 44, 67. 39. Notably, some policies contain language that specifically precludes the consideration of policyholder-favorable economic conditions post-loss when valuing the business interruption loss. Such policies commonly are worded as follows: The amount of Business Income loss will be determined based on: (1) The Net Income of the business before the direct physical loss or damage occurred; (2) The likely Net Income of the business if no physical loss or damage occurred, but not including any likely increase in Net Income attributable to an increase in the volume of business as a result of favorable business conditions caused by the impact of the Covered Cause of loss on customers or on other businesses.... Legier & Co. v. Travelers Indem. Co. of Conn., No. 09-6674, 2010 WL 1731202, at *2 (E.D. La. Apr. 28, 2010). See also Berk-Cohen Assocs, 2009 WL 2777163, at *3; Rimkus Consulting Grp., Inc. v. Hartford Cas. Ins. Co., 552 F. Supp. 2d 637, 640 (S.D. Tex. 2007).

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 473 surprise that the courts decisions regarding how business interruption losses should be valued are varied and inconsistent. Some courts interpret the valuation language to require that the loss calculation be based upon only the historical financial data of the policyholder. 40 Other courts also allow the local post-catastrophe economic conditions to be considered. 41 In addition, when applying the standard valuation language to claims that arise under similar factual scenarios, the courts have reached patently inconsistent conclusions regarding which of the policyholder s ongoing expenses are recoverable. 42 One consistency, however, does appear in the decisions the courts are confused regarding the evidentiary standard that should apply when a policyholder is attempting to prove the amount of its business interruption loss. 43 A. Courts That Have Interpreted the Loss Valuation Language to Allow for Consideration of Only Historical Financial Data One school of thought, which most notably has been endorsed by the Fifth Circuit, only considers the historical financial data of the policyholder when calculating business interruption losses. 44 In Finger Furniture, 45 the policyholder owned seven furniture stores in Houston, Texas. 46 Tropical Storm Allison hit the Houston area and 40. See infra Part II.A. 41. See infra Part II.B. 42. See infra Part II.C. 43. See infra Part II.D. 44. Catlin Syndicate Ltd. v. Imperial Palace of Miss., Inc., 600 F.3d 511, 514 (5th Cir. 2010) (following Finger Furniture and only allowing the use of historical financial information when determining a business interruption loss); Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005) (allowing only historical financial information to be used to predict policyholder s probable experience during period of interruption); Prudential LMI Commercial Ins. Co. v. Colleton Enters., Inc., No. 91-1757, 1992 WL 252507, at *4 (4th Cir. Oct. 5, 1992) (disallowing the policyholder to calculate its business interruption loss based upon favorable post-loss economic environment created by a hurricane); Am. Auto. Ins. Co. v. Fisherman s Paradise Boats, Inc., No. 93-2349CIVGRAHAM, 1994 WL 1720238, at *4 (S.D. Fla. Oct. 3, 1994) (citing Colleton, 1992 WL 252507, at *2) (finding increased demand for policyholder s products due to favorable economic environment created by a hurricane cannot be considered when valuing the policyholder s business interruption loss). 45. Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312 (5th Cir. 2005). 46. Id. at 313.

474 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 caused severe flooding. 47 As a result, the policyholder could not open its stores for a period of time. 48 Consequently, the policyholder submitted a business interruption loss claim to its insurer. 49 The parties could not agree on the amount of the business interruption loss, litigation ensued, and ultimately the parties filed cross motions for summary judgment. 50 The policy at issue contained the following language: In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred. 51 Relying upon the probable experience thereafter policy language, the insurer argued the policyholder did not actually suffer a business interruption loss because demand for furniture in the area was high after the tropical storm passed and the policyholder was able to quickly make up the sales allegedly lost during the period of interruption. 52 The Fifth Circuit rejected the insurer s argument and held that only the policyholder s historical sales figures could be used to calculate the loss. 53 In explaining its decision, the court stated: The policy language indicates that a business-interruption loss will be based on historical sales figures. Specifically, the policy states that due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred. Historical sales figures reflect a business s experience before the date of the damage or destruction and predict a company s 47. Id. 48. Id. 49. Id. 50. Id. 51. Finger Furniture, 404 F.3d at 314. 52. Id. 53. Id.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 475 probable experience had the loss not occurred. The strongest and most reliable evidence of what a business would have done had the catastrophe not occurred is what it had been doing in the period just before the interruption. 54 The court further explained that, contrary to the insurer s position, the policy did not expressly state that post-catastrophe sales should be considered when determining what the sales would have been had the storm not occurred: [T]he business-loss provision says nothing about taking into account actual post-damage sales to determine what the insured would have experienced had the storm not occurred. The contract language does not suggest that the insurer can look prospectively to what occurred after the loss to determine whether its insured incurred a business-interruption loss. Instead, the policy requires due consideration of the business s experience before the date of the loss and the business s probable experience had the loss not occurred. [The policyholder s] historical sales figures reflect that consideration. 55 Thus, in this instance, the court s decision not to consider the postcatastrophe economic conditions favored the policyholder. Five years later, the Fifth Circuit reaffirmed its commitment to considering only the policyholder s historical financial information when valuing business interruption losses in Catlin Syndicated Ltd. v. Imperial Palace of Mississippi, Inc. 56 In Catlin, the policyholder operated a casino that was damaged by Hurricane Katrina. 57 The casino was shut down for several months, but when it reopened its revenues were... greater than before the hurricane[,] because many [of the] nearby casinos remained closed. 58 In valuing the 54. Id. 55. Id. 56. See Catlin Syndicate Ltd. v. Imperial Palace of Miss., Inc., 600 F.3d 511, 516 (5th Cir. 2010). 57. Id. at 512. 58. Id.

476 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 business interruption loss for the casino, there was a $100 million discrepancy between the policyholder s calculation, which was based in part upon the business s post-hurricane experience, and the insurer s calculation, which was based upon only the business s prehurricane experience. 59 The valuation language in the policy at issue was worded as follows: In determining the amount of the Time Element 60 loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience thereafter had no loss occurred. 61 With each party arguing that the court should adopt their interpretation of the policy language, the parties filed cross-motions for summary judgment. 62 The court, relying upon Finger Furniture, held only the historical sales information could be used to calculate the loss. 63 The court explained its reasoning as follows: Finger Furniture tells us that a business-interruption loss will be based on historical sales figures, and that we should not look prospectively to what occurred after the loss. Thus, in the business-interruption provision at hand, only historical sales figures should be considered when determining loss, and sales figures after reopening should not be taken into account. 64 Thus, unlike in Finger Furniture, the court s decision not to allow post-catastrophe economic conditions to be considered favored the insurer. In both cases, however, the Fifth Circuit interpreted the probable experience thereafter phrase to mean the probable experience the 59. Id. at 512 13. 60. Business interruption insurance is a type of insurance that sometimes is referred to as time element insurance, because the period of time a business is interrupted is one of the principal factors involved in valuing the loss. Bernard P. Bell, General Purpose of Time Element Insurance, in 5 NEW APPLEMAN ON INSURANCE LAW LIBRARY EDITION 46.01 (2013). 61. Catlin, 600 F.3d at 513. 62. Id. 63. Id. at 516. 64. Id. (citing Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005)).

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 477 policyholder would have had post-catastrophe, assuming the policyholder s post-catastrophe experience would be identical to its pre-catastrophe experience. 65 Several courts in other jurisdictions have reached similar conclusions. 66 B. Courts That Have Interpreted the Loss Valuation Language to Allow for the Consideration of Local Economic Conditions Post- Catastrophe At the other end of the spectrum, several courts have held that local post-catastrophe economic conditions should be considered when business interruption losses are valued. 67 Although there are not enough decisions, particularly appellate decisions, on the issue to proclaim that any particular school of thought is the majority position, more courts, especially in Louisiana, have endorsed this approach than the Fifth Circuit s approach. 68 A leading case, and arguably the controlling authority on the issue under Louisiana law, that used this approach is Sher v. Lafayette Insurance Co. 69 In Sher, the policyholder owned an apartment building in New Orleans that was damaged by Hurricane Katrina. 70 Although there were multiple issues in dispute between the policyholder and the insurer, the primary dispute with respect to the 65. Id. at 514; Finger Furniture, 404 F.3d at 314. 66. See supra note 44. 67. Fireman s Fund Ins. Co. v. Holland Am. Line-Westours, Inc., 25 Fed. App x 602, 603 (9th Cir. 2002) (allowing insurer to use make up sales of the policyholder post-loss to reduce the amount owed); Consol. Cos. v. Lexington Ins. Co., No. 06-4700, 2009 U.S. Dist. LEXIS 8542, at *20 (E.D. La. Jan. 23, 2009) (allowing jury to base award to policyholder upon increased demand created by hurricane); Berk-Cohen Assocs. v. Landmark Am. Ins. Co., No. 07-9205, 2009 WL 2777163, at *5 (E.D. La. Aug. 27, 2009) (allowing policyholder to use higher post-loss rent values when calculating its business interruption loss); B.F. Carvin Constr. Co. v. CNA Ins. Co., No. 06-7155, 2008 WL 5784516, *3 (E.D. La. July 14, 2008) (finding policyholder did not suffer a business interruption loss because favorable economic conditions post-loss caused an increase in sales); Levitz Furniture Corp. v. Hous. Cas. Co., No. 96-1790, 1997 WL 218256, *3 (E.D. La. Apr. 28, 1997) (allowing policyholder to calculate its business interruption loss based upon higher demand for its product caused by flooding); Sher v. Lafayette Ins. Co., 973 So. 2d 39, 62 (La. Ct. App. 2007), aff d in part, rev d in part, 988 So. 2d 186, 205 (La. 2008) (allowing policyholder to use higher post-loss rent values in calculating its business interruption loss). 68. See cases cited supra note 67. 69. Sher, 973 So. 2d at 47. 70. Id.

478 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 business interruption claim related to whether pre-katrina or post- Katrina rent rates should be used to value the business interruption loss. 71 The policy language at issue provided: We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your operations during the period of restoration. 72 The policyholder argued that, under this language, post-katrina rent rates should be used because housing had become scarce due to the extensive damage in the area, while the insurer argued pre-katrina rates should be used. 73 The case was tried to a jury and the jury found in favor of the policyholder. 74 On appeal, the intermediate appellate court, with little explanation, held that the policyholder could recover the higher post- Katrina rent rates, stating the Policy covers [the policyholder s] actual loss of business income. 75 In making this statement, the court implicitly interpreted the phrase actual loss to mean the amount the policyholder would have earned if the policyholder s business had not been damaged by the hurricane but the area around the policyholder s business had been damaged. 76 Because the jury agreed with the policyholder s loss calculation using the post-katrina rent rates, the court affirmed the jury verdict. 77 On appeal, the Supreme Court of Louisiana reversed the lower courts rulings on some issues, but not the holdings regarding the valuation of the business interruption loss. 78 Thus, the Louisiana state courts implicitly rejected the Fifth Circuit s approach by allowing the consideration of post-catastrophe economic conditions in valuing the loss. 79 71. Id. at 57. 72. Id. 73. Id. 74. Id. at 49. 75. Sher, 973 So. 2d at 57. 76. Id. 77. Id. 78. Sher v. Lafayette Ins. Co., 988 So. 2d 186, 205 (La. 2008). 79. See cases cited supra note 67.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 479 Another Louisiana decision in which the court held the policyholder s business interruption loss should be calculated based upon post-catastrophe economic conditions is Berk-Cohen Associates, LLC v. Landmark American Insurance Co. 80 In Berk- Cohen, the policyholder was the owner of an apartment complex that was damaged by a series of unfortunate events. 81 First, a tornado struck the apartment complex. 82 Two weeks later, before any repairs had been made, Hurricane Katrina decimated New Orleans and further damaged the apartment complex. 83 Then, while the post- Katrina repairs were underway, a fire broke out at the apartment complex. 84 Finally, while repairs were again underway, a vehicle struck a transformer, which caused a power outage. 85 From beginning to end, the repair work took almost two years to complete. 86 When valuing the business interruption loss, the parties could not agree on the amount of the loss because, among other reasons, the policyholder contended the housing shortage caused by Hurricane Katrina increased the rental value of the apartments by 40%. 87 The insurer, on the other hand, valued the loss based upon pre-katrina rates. 88 The valuation language in the policy provided: The amount of Business Income loss will be determined based on: (1) The Net Income of the business before the direct physical loss or damage occurred; (2) The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause 80. Berk-Cohen Assocs. v. Landmark Am. Ins. Co., No. 07-9205, 2009 WL 2777163 (E.D. La. Aug. 27, 2009). 81. Id. at *1. 82. Id. 83. Id. 84. Id. 85. Id. 86. Berk-Cohen, 2009 WL 2777163, at *1. 87. Id. at *3. 88. Id.

480 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 of Loss on customers or on other businesses[.] 89.... In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred. 90 The court held the policyholder s recovery should be based upon the post-katrina rental rates. 91 In reaching its holding, the court distinguished Finger Furniture, 92 the ostensibly controlling Fifth Circuit authority, by accepting the policyholder s argument that: (1) the policy language at issue was different than the language in Finger Furniture, and (2) the policy language quoted above that provides the loss will not be valued based upon favorable post-catastrophe business conditions created by a covered cause of loss did not apply because flooding, an excluded cause of loss, as opposed to a covered cause of loss, created the favorable business conditions 93 Thus, the court allowed the policyholder to successfully circumvent the policy language which, on its face, appeared to preclude consideration of the favorable post-catastrophe business conditions in the area. Although the reasoning has varied somewhat from decision to decision, several other courts also have reached the conclusion that post-catastrophe economic conditions should be considered when valuing business interruption losses. 94 89. Id. 90. Id. at *4 (citing Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005)). 91. Id. at *5. 92. Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005). 93. Berk-Cohen, 2009 WL 2777163, at *5. 94. See supra note 67.

2014] VALUING BUSINESS INTERRUPTION INSURANCE LOSS 481 C. Courts Inconsistent Holdings Regarding the Application of the Loss Valuation Language In addition to disagreeing on whether post-catastrophe economic conditions should be considered when analyzing business interruption losses, the courts also have reached inconsistent conclusions regarding when, and whether, certain expenses are recoverable under the standard valuation language contained in business interruption policies. 95 This inconsistency is highlighted by 95. Compare Nat l Union Fire Ins. Co. of Pittsburgh v. Anderson-Prichard Oil Corp., 141 F.2d 443, 446 (10th Cir. 1944) (affirming lower court s ruling in favor of policyholder and finding no prescribed formula for the determination of the actual loss of net profits and business expenses covered by the policy ), Legier & Co. v. Travelers Indem. Co. of Conn., No. 096674, 2010 WL 1731202, at *1, *3 (E.D. La. Apr. 28, 2010) (allowing policyholder to recover net income plus continuing fixed costs but requiring the policyholder to credit the insurer with revenues received during the period of interruption and noting the policy does not prescribe an explicit formula to calculate loss of business income ), Amerigraphics, Inc. v. Mercury Cas. Co., 107 Cal. Rptr. 3d 307, 320 (Cal. Ct. App. 2010) (allowing policyholder to recover its continuing fixed costs even if it would have suffered a loss during the period of interruption in the absence of a flood), and Gates v. State Auto. Mut. Ins. Co., 196 S.W.3d 761, 766 67 (Tenn. Ct. App. 2005) (allowing policyholder to recover revenues that would have been received after the period of interruption so long as they were earned during the period of interruption), with Polymer Plastics Corp. v. Hartford Cas. Ins. Co., 389 F. App x 703, 705 (9th Cir. 2010) (holding that earnings made during period of interruption should be used to reduce the amount of the business interruption loss), Associated Photographers, Inc. v. Aetna Cas. & Sur. Co., 677 F.2d 1251, 1256 (8th Cir. 1982) (holding the insurer can deduct the amount of saved variable expenses when calculating the amount of a business interruption loss), Nw. States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531, 534 (8th Cir. 1966) (finding where inventory was sold to prevent loss of earnings during period of business interruption, only the extra expenses incurred to replace the inventory sold was recoverable), HTI Holdings, Inc. v. Hartford Cas. Ins. Co., No. 10-6021-AA, 2011 WL 6205903, at *7 (D. Or. Dec. 8, 2011) (holding that projected negative net income during period of interruption can be used by insurer to offset continuing fixed costs when calculating a business interruption loss amount), Admiral Indem. Co. v. Bouley Int l Holding, LLC, No. 02 Civ. 9696(HB), 2003 WL 22682273, at *2 (S.D.N.Y. Nov. 13, 2003) (holding amounts paid to policyholder for different use of property during period of interruption should be used to reduce amount of the business interruption loss), Stone Container Corp. v. Arkwright Mut. Ins. Co., No. 93C6626, 1997 U.S. Dist. LEXIS 3978, at *8 9 (N.D. Ill. Mar. 25, 1997) (finding that policyholder did not suffer a business interruption loss because it was able to satisfy orders by selling inventory which the policyholder did not replenish after the period of interruption), Baxter Int l, Inc. v. Am. Guarantee & Liab. Ins. Co., 861 N.E.2d 263, 271 (Ill. App. Ct. 2006) (holding insurer can use policyholder s sales during period of interruption to reduce amount of policyholder s loss), Lyon Metal Prods., LLC v. Prot. Mut. Ins. Co., 747 N.E.2d 495, 504 (Ill. App. Ct. 2001) (finding insurer can offset payments made for damaged inventory when calculating the value of the business interruption loss), Cohen Furniture Co. v. St. Paul Ins. Co. of Ill., 573 N.E.2d 851, 857 (Ill. App. Ct. 1991) (holding policyholder cannot recover depreciation for a completely destroyed building because depreciation is not a continuing expense under business interruption insurance in that circumstance), J&R Elecs. Inc. v. One Beacon Ins. Co., No. 603284/2004, 2005 WL 4257996, at *2 (N.Y. Sup. Ct. Dec. 13, 2005) (holding policyholder cannot recover for damaged merchandise under both property damage provisions of policy and business interruption provisions of policy), Cont l Ins. Co. v. DNE Corp., 834 S.W.2d 930, 934 (Tenn. 1992) (finding insurer must add projected net income

482 GEORGIA STATE UNIVERSITY LAW REVIEW [Vol. 30:2 the courts treatment of the issue of whether a policyholder can recover its continuing fixed expenses such as rent and payroll in situations where the policyholder likely would have lost money during the period of interruption, even if its operations had not been interrupted. 96 Consider again the insuring agreement provisions commonly found in standard business interruption policies: [The insurer] will pay an insured during its period of suspended business operation the (i) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred... ; and (ii) Continuing normal operating expenses incurred, including payroll[.] 97 Thus, a question that arises is whether a policyholder can recover its continuing operating expenses during the period of interruption if it was actually losing money prior to the business interruption and was projected to continue losing money during the period of interruption even if the interruption had not occurred. In other words, does one add together the projected net income and continuing operating expenses in determining the recoverable loss or are the continuing operating expenses recoverable regardless of whether the net income figure is positive or negative? and continuing expenses together when calculating a business interruption claim even if the net income number is negative), and Keetch v. Mut. of Enumclaw Ins. Co., 831 P.2d 784, 786 (Wash. Ct. App. 1992) (holding decrease in business activity due to a partial interruption of business, as opposed to a complete interruption of business, is not a reimbursable business interruption loss). 96. Compare Amerigraphics, 107 Cal. Rptr. 3d at 318 (allowing insured to recover its continuing fixed costs), with DNE, 834 S.W.2d at 934 (denying insured recovery of business income). 97. Amerigraphics, 107 Cal. Rptr. 3d at 312. See also Catlin Syndicate Ltd. v. Imperial Palace of Miss., Inc., 600 F.3d 511, 514 (5th Cir. 2010); Finger Furniture, 404 F.3d at 314; Prudential LMI Commercial Ins. Co. v. Colleton Enters., Inc., No. 91-1757, 1992 WL 252507, at *1 (4th Cir. Oct. 5, 1992); Berk-Cohen, 2009 WL 2777163, at *4; Consol. Cos. v. Lexington Ins., No. 06-4700, 2009 U.S. Dist. LEXIS 8542, at *16 17 (E.D. La. Jan. 23, 2009); B.F. Carvin Constr. Co. v. CNA Ins. Co., No. 06-4700, 2008 WL 5784516, at *1 (E.D. La. July 14, 2008); Levitz Furniture Corp. v. Hous. Cas. Co., No. 96-1790, 1997 WL 218256, at *3 (E.D. La. Apr. 28, 1997); Am. Auto. Ins. Co. v. Fisherman s Paradise Boats, Inc., No. 93-2349CIVGRAHAM, 1994 WL 1720238, at *3 (S.D. Fla. Oct. 3, 1994).